Target Shares Plunge on Soaring Freight Costs, Bloated Inventory

Worse-than-expected logistics constraints, excess inventory and a sales slowdown in several categories, including electronics, slammed Target in Q1 FY 2022 ended April 30, sending the stock plunging Wednesday 24.9% to $161.71.

Unexpectedly high freight costs will tack on $1 billion to Target’s 2022 balance sheet after adding “hundreds of millions of dollars” to the retailer’s “already elevated expectations” in Q1, said Chief Operating Officer John Mulligan on a Wednesday earnings call. The retailer anticipated “tight conditions and elevated costs” coming into 2022, but “actual conditions and costs have been more challenging than expected,” Mulligan said.

Mulligan cited high fuel costs and the global shipping market, “where costs have stayed unusually high,” forcing the company to have to rely at times on the spot market to secure capacity. Volatility in consumer demand and delivery times put “additional stress” on the retailer's supply chain, which “was already running lean on capacity” after outsized COVID-19-driven growth over the past two years.

“We ended up carrying too much inventory” in several categories, Mulligan said, “where the slowdown in sales were more pronounced than expected,” including electronics. Chief Growth Officer Christina Hennington said Target had to make “difficult trade-off decisions” as supply grew and demand shifted away from “bigger, bulkier products,” such as TVs and furniture, to make room for fast-growing categories.

That led to markdowns that crushed gross margin, Hennington said. Operating margin of 5.3% “was well below expectations” and will be in a “wide range” around that for Q2, said Chief Financial Officer Michael Fiddelke, saying excess inventory hampering Q1 performance will continue into the current quarter. For the year, Target expects operating income margin rate to be “in a range centered around 6%” vs. previous guidance of 8%, he said, referencing current volatility and “multiple sources of uncertainty going forward.”

Though Target expects improvement in inventory in the second half, “we don’t expect the external environment will be anything close to normal” in the second half, Fiddelke said, saying global supply chain troubles won’t ease “until 2023 at the earliest.”

On whether Target will pass through higher costs to consumers, CEO Brian Cornellsaid the company is “looking at this very carefully.” It will balance managing costs with providing affordability to customers “in a time of need.”

Responding to an analyst’s question on why Target didn’t anticipate the impact of rapidly rising costs in its March analysts day, Cornell said the company “did not anticipate that transportation and freight costs would soar the way they have, as fuel prices have risen to all-time highs.” Though it expected to feel an impact from lapping an outsized Q1 2021 fueled by stimulus spending, “we did not expect to see the dramatic shift” in certain categories, including that from “TVs to luggage.” He expects that to continue in Q2.

Q1 revenue grew 4% year on year to $25.2 billion in the quarter ending April 30; operating income fell 43.3% to $1.3 billion; profit plunged 52% to $1 billion, the company said. Store comparable sales increased 3.4%, on top of 18% growth last year, and digital comp sales grew 3.2%, after 50.2% growth last year.

Fiddelke noted that Q1 earnings per share at $2.16 were 40% higher than in Q1 2019; they were $4.17 in Q1 2021. Cornell said the company feels good about 3.3% higher comparable sales in Q1 “on top of 23% last year” and a nearly 4% increase in traffic, which he said indicated customer confidence. Cornell told analysts that despite “meaningful pressure on near-term performance,” Target’s business is “profitable and very healthy.”